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Summer Markets

Weekly Fixed Income Comment – 24 July 2017

Overall Markets
Whilst it was a week where the set pieces were dominated by Europe, in the form of the ECB meeting, the US Treasury market and US dollar were most relevant to MENA bonds and sukuk last week. Positive returns were mainly driven by the US Treasury rally, that included a flattening yield curve that reversed the earlier steepening further, and the continued weakness of the dollar as this is a trend that continues to be friendly for emerging market assets. Whilst the ECB’s lack of hawkishness (i.e. there was no attempt to bring forward either the consideration or reality of reduced quantitative easing or to raise the spectre of rates hikes in 2018) was supportive of lower Bund yields and by association lower Treasury yields, US data also helped. Of the main economic indicators that were released last week, two were a bit softer and two were a bit stronger. If beauty is indeed in the eye of the beholder then the Treasury market is bound to focus on the softer data in its current mood. So the Empire State and Philly Fed surveys outdid the housing market data, even if the net result according to the New York Fed Nowcast that we often refer to was that their estimate of Q3 growth increased to 1.95%. This week’s diet of PMIs, consumer confidence indicators, Fed meeting, durable goods orders, Q2 GDP and inflation data in the US will be filling. Although the summer is reducing volumes in the markets as expected, there is still movement and interest.

Bond Funds & Mandates

In The RegionMENA credits had a good week, largely on the back of the US Treasury market as credit spreads were broadly stable. The OAS (option adjusted spread) for the Bloomberg UAE Index widened by 1 bp to 135 bps, the spread for the broader JP Morgan MECI (Middle East Composite Index) tightened by 2 bps to 205bps. In this environment some of the recent higher beta credits, such as those from Oman and Qatar, fared best.

The IMF published reports following the conclusion of annual Article IV consultations. For Saudi Arabia, although they continue to expect some pick up in non-oil growth this year, overall GDP growth is still expected to be close to zero. The latest numbers for the fiscal deficit are 17.2% of GDP in 2016 and 9.3% in 2017. A small current account surplus is expected for this year, although overall financial flows will continue to be slightly negative (i.e. outflows and lower SAMA assets). The early stages of the reform process were praised, whilst the need for effective implementation was also noted. For the UAE, the improvement in non-oil growth was also mentioned, in line with previous statements, with 3.3% growth seen this year and support in the years ahead from Expo 2020 and global trade. As with Saudi Arabia, they noted the need for sustained fiscal reforms. Overall GDP growth is projected at 1.3% this year and 3.4% next year, the current account balance seen at 2.6% and 2.8% of GDP respectively.

The news from Financials during the earnings season, has generally been comforting with more positive surprises than negative and ongoing, moderate loan growth, cost control and margin improvement. ADCB was a notable exception as Q2 profits declined to AED 1.01 billion, lower than expectations and versus last year, although this was due to one off items as opposed to the underlying business.

S&P affirmed the ratings and outlooks of a number of the emirates: Sharjah (BBB+/stable), RAK (A/stable) and Abu Dhabi (AA/stable).

There was some activity in the primary markets with Topaz Marine inviting tenders of their callable notes due in 2018, and successfully issuing USD 375 million of senior unsecured notes maturing in 2022 (callable 2019). The deal was priced at a YTM of 9.125% and attracted interest of up to USD 750 million from different investors. There was a notable deal by Dubai Aerospace, 80% owned by ICD, as they quietly raised USD 2.3 billion; 500 million 3-year notes at 4%, 800 million 5-year notes at 4.50% and USD 1 billion 7-year notes at 5%.

Out of RegionThe JP Morgan EMBI Global Diversified (US dollar denominated, sovereign, emerging market bonds) gained 76 bps last week. The underlying return from US Treasuries was the main contributor. Africa, the recent high beta region, was the best performing region with a gain of 115 bps and Asia was the lowest with a gain of 68 bps. El Salvador, Honduras and Mexico performed well with an average gain of 209 bps, while Venezuela, Tanzania and Argentina did poorly with an average loss of 225 bps. Close to home, Turkey had a good week. High Grade bonds performed better than High Yield ones. For the corporate sector, the CEMBI Broad Diversified (US dollar denominated, corporate, emerging market bonds) gained 45 bps also driven by Treasuries. Similarly, Asia was the worst performer with a gain of 30 bps while Africa was the best performer with a gain of 63 bps. Telecom was the best performing sector with a 72 bps gain while Real Estate trailed with a 20 bps gain.

In local currency markets, the JP Morgan GBI-EM Global Diversified index was up 20 bps in US dollar hedged terms last week. Currency returns were also positive with the unhedged return recording a 96 bps gain. Middle East and Africa was the best performing region with a gain of 63 bps, while LatAm was the lowest with a gain of 4 bps. Peru was the best performing country with a 133 bps gain in US dollar hedged terms. The market rallied on the back of the central bank cutting interest rates to revive economic growth. The sale of the first sol-denominated bonds that can be settled through Euroclear also contributed to the rally. Brazil and Indonesia also performed well with gains of 69 bps and 67 bps respectively in US dollar hedged terms. The Brazilian government continues to push on with its reform agenda despite the ongoing political scandal. In Indonesia, the government abandoned the possibility of raising the debt limit, which was well received by investors. Argentina was the worst performer last week with a loss of 152 bps in US dollar hedged terms. The midterm elections are already negatively affecting the market, the return of the former President with her new political party is a possibility. Chile and Mexico also performed poorly with 44 bps and 37 bps losses respectively in US dollar hedged terms. The Chilean market failed to recover despite the rally in copper because weak business confidence and a slowdown in the construction sector are the main drivers of the ongoing economic downturn. In Mexico, local issues regarding security are being brought to the fore with the latest data, with the first half of 2017 being the deadliest period since 2001.

In FX markets, the Hungarian forint, Romanian leu and Brazilian real performed well last week. The laggards were Mexican peso, Russian ruble and the Philippine peso.

The FundsOur internal systems show that the MENA Bond Fund (MBF) was up by 0.42% last week to July 21st. The Bloomberg UAE Index was up by 0.30% whilst the JP Morgan MECI and the JP Morgan MECI GCC indices were up by 0.51% and 0.49% respectively, so MBF’s performance was in line with the broad market. According to the 20th July NAV, MBF was up 2.81% year to date.The yield of MBF is 4.37%.

The Sukuk Income Fund (SIF) was up by 0.26% last week to Friday 21st July, according to our internal systems. Indices were up too, the JP Morgan MECI Sukuk Index and the Dow Jones Sukuk Index were up by 0.29% and 0.25% respectively. According to the 19th July NAV, SIF was up by 1.26% year to date.The profit rate for SIF is 4.27%.

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